The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Friday, May 25, 2012

Adding to lack of credibility, ECB and IMF to also oversee audits of Spain's banks

In an attempt to add credibility, Reuters reports that the ECB and IMF are going to oversee the meaningless Spanish bank audits.

Regular readers will recall that the Troika, including the ECB and the IMF, had this role in the failed audit of the Irish banks performed by BlackRock Solutions.

The reason these audits do not succeed is very simple. No market participant trusts them as they are not accompanied by the banks providing ultra transparency and disclosing on an on-going basis their current asset, liability and off-balance sheet exposure.

With this disclosure, market participants could independently confirm the results of the audit.

Without this disclosure, market participants have to assume that the government, ECB, IMF and the banks have something to hide.

The basis for the belief that the government, ECB, IMF and the banks have something to hide can be seen in the rapidly escalating price tag for the Bankia bailout. It has climbed from 9 billion to 15 billion euros in one day. This shows there is zero chance that the government and its financial regulators are on top of even the most obvious losses in the Spanish banking system.

International institutions will oversee an audit of Spain's banks aimed at reassuring investors that bailout costs will not spiral as the prospect of new Spanish borrowing threatens to further inflame the eurozone crisis.

Spain's weak banks and overspending regions are central to the European debt crisis as many investors believe the government will only be able to support them by seeking international aid....

Is the goal of the audit to uncover the true condition of the banks or is the goal of the audit to reassure investors that the Spanish government will not need an international bailout?

A government source said the European Central Bank and International Monetary Fund would oversee an external audit aimed at easing concerns over the health of the banking sector. The source said full details were yet to be decided.

"You have to include them in a way because there is a significant amount of distrust placed by investors on figures provided by the Bank of Spain and the Treasury," Citi economist Guillaume Menuet said.

"It's a bit of a double-edged sword, though, because if the figures turn out to be too optimistic it hurts their credibility."

If the banks aren't required to provide ultra transparency, the audits aren't worth a single euro as nobody believes the results (see above and the discussion of there is something to hide).

Four stages of banking reforms have failed to convince investors that the financial sector has fully accounted for losses from a 10-year property boom that burst in 2007-2008.

The aim of the external audits, due to be completed by mid-June, is to put a definitive number on how much the government might have to spend to shore up banks after forcing them to recognise 137 billion euros in losses.

The government named consultancies Oliver Wyman and Roland Berger to audit the banks from the top down and look at how they would weather a prolonged recession. Three or four other firms will examine bank books and real estate holdings from the bottom up....

This is a repeat of the Irish experience. It confirms that the Spanish government, the ECB and the IMF have learned absolutely nothing from the Irish experience and the failure of its audit.

"The risk is quite high that Spain will need outside help, at least on the recapitalisation side," said ING rate strategist Alessandro Giansanti....

Recapitalization that is completely unnecessary!

Remember, in a modern banking system with deposit guarantees and access to central bank funding, banks can operate and support the real economy for years with negative book capital levels.

"In the end everything goes back to the banks in Spain, which is another reason we need resolution on the banks as soon as possible," said Gilles Moec, economist at Deutsche Bank.

The only proven way to get resolution on the banks is to require the banks to provide ultra transparency. Absent ultra transparency, there is zero reason for investors to believe the results.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.